By Reynaldo A. De Dios
When huge losses occur due to natural calamities and insurers are reported as having settled their enormous obligations, the insuring public often wonders at the financial ability of these insurers to make good their promise of indemnification. So much so that many are led to believe that the funds of insurance companies are almost inexhaustible. Such is not the case. The secret behind it all is REINSURANCE.
Reinsurance is the term used to denote the transaction whereby an insurer who has insured a huge risk in turn insures a part of it with another company. As mandated by the Philippine Insurance Code, no insurer is allowed to retain for its own risk 20 percent of its net worth. The company offering insurance of this nature is called the ceding office, whilst the one accepting is known as the reinsurer.
As a rule, the conditions on reinsurance are the same as those that apply to the original insurance. Hence, the reinsurer receives the same rate of premium and must pay its proportionate share of any claim. However, the commission granted by the reinsurer to the ceding office is higher as in addition to the commission paid the agent of the ceding office, it also includes the expense involved in transacting the business. There are several classes of reinsurance treaties and these are as follows.
1. Quota Share is one whereby the ceding company is required to cede a fixed percentage of every risk it accepts from its clients. This class of treaty is not in common use as the ceding company loses in exercising its judgment of determining its retention.
2. The Surplus Treaty is very much preferred by insurers since they have the privilege of first fixing their retention before reinsuring the surplus of the risk.
3. The Excess of Loss Treaty is an agreement under which no part of any individual risk is reinsured but the ceding company arranges to seek protection only for the excess of any one loss above an agreed amount. This class of treaty will test the skill of the ceding company’s underwriter.
When a huge loss occurs and the insurer is reimbursed by its reinsurers, the question arises: How is it that reinsurers find it possible to settle all their obligations? The financial ability of the reinsurers to meet their commitments under their treaties is traced directly to another man-devised protection method termed RETROCESSION. It is defined simply as a reinsurance of a reinsurer. In other words, a reinsurer after receiving particulars of the risks ceded, will in turn arrange treaties with other companies to reinsure its surplus risks.
Retrocession thus occupies an important role in the insurance industry. Without it, a reinsurer will be unable to relieve itself of the accumulation of risk resulting from receiving shares of the same risk in its different treaties. It may be concluded that the underwriting business is international in scope and as a whole has no geographical or racial limits.
Even in life assurance, the same principle applies as life insurance companies will also limit their policy on an individual to an amount that is within their financial resources and underwriting standards. However, life insurers only reinsure the mortality risk of their policyholders but the savings portion of the premium is invested under the guidelines set in the Insurance Code and by the Insurance Commission.
In conclusion, reinsurance and retrocession play vital roles as without these concepts, the world insurance industry would not be able to efficiently service the risks of commerce and industry as well as the needs of the individual life policyholder for the benefit of their families and loved ones.
The author is a risk management consultant and Editor of Insurance Philippines magazine.